Facebook’s $5 Billion IPO: The Next Google? Or The Next Groupon?

Facebook filed the prospectus for its initial public offering on Wednesday morning. Above, CEO Mark Zuckerberg at a 2011 event in San Francisco. Photo: Jon Snyder/Wired.com

Facebook is finally going public.

On Wednesday, Facebook filed the prospectus for its initial public offering. The social giant seeks to raise $5 billion in initial funding. That’s in line with some of the largest IPOs in technology history, and it comes eight years after the company was first launched in the Harvard dorm room of CEO Mark Zuckerberg. According to the company’s IPO filing, in 2011, it recorded revenue of $3.7 billion, operating income of $1.75 billion, and net income of $1 billion. While the company’s S-1 filing does not list how much shares will cost upon the date of the IPO, Facebook’s most recent estimate as of December 31 puts the per share price at $29.73.

Facebook (FB) by the Numbers

Initial funding goal: $5 billion

Estimated share value: $29.73

2011 Revenue: $3.7 billion

2011 Operating income: $1.75 billion

2011 Net income: $1 billion

Monthly active users (December 2011): 845 million

Daily active users (December 2011): 483 million

2011 R&D spending: $388 million

Sheryl Sandberg 2011 compensation: $30.9 million

Mark Zuckerberg 2011 compensation: $1.49 million

Given Facebook’s size and popularity — the social network has over 845 million members worldwide — eight years is actually quite a long time. Over that period, Facebook had unprecedented access to capital, and on sites like SharesPost and SecondMarket, pre-IPO prospectors have been able to purchase and trade shares in the company from employees and other early stakeholders. The company’s relative maturity means that most of the millions — or billions — that could be made from buying public shares have probably already been made.

This could mean Facebook’s IPO will meet a fate similar to that of this year’s other high-profile tech IPOs. Both Zynga and Groupon actually sank below their IPO share price — right out of the gate — a sign of failure on Wall Street. “The tech class of 2011 has underperformed,” said Paul Kedrosky, a prominent financial blogger and senior fellow at the Kauffman Foundation, in an interview. “Because of secondary markets, that post-IPO balance happened pre-IPO. My expectation is, Facebook will see a very similar phenomenon.”

Regardless, the IPO will put cash in the pockets of the many paper millionaires surrounding the company, and it will inject a massive amount of capital into Facebook’s coffers. This capital will allow the company to invest more in its products and grow its revenue streams. But this comes with its own problems. In order to grow revenues, some analysts believe, Facebook must find a way to better target ads on its service. This means tapping the vast array of personal data it has collected about its users, which could easily raise the ire of both users and government regulators.

And fine-tuning its ads is crucial, given that it’s the company’s predominant revenue stream: Currently, advertising accounts for 84 percent of the company’s $3.7 billion in revenues.

What’s more, when the company is traded on public markets, it must be more transparent and more regularly disclose its finances and activities. Soon, all prospective investors — that is, everyone — will be privy to information the company has previously been reluctant to share beyond a close inner circle of early investors and friends.

The Facebook Paradox

Facebook is a paradox. Throughout its history, it has been both open and closed. It began as a closed social network for Harvard students, but within that closed network, it sought to push the boundaries of each user’s privacy. So much of Facebook’s culture — especially its boundary-challenging, generation-defining norms of sharing and privacy — stems from those early days as a place where Harvard students could meet, socialize, and share (often embarrassing) photos of each other.

Mark Zuckerberg’s Letter to Investors: ‘The Hacker Way’

Facebook was not originally created to be a company. It was built to accomplish a social mission — to make the world more open and connected.

We think it’s important that everyone who invests in Facebook understands what this mission means to us, how we make decisions and why we do the things we do. I will try to outline our approach in this letter.

At Facebook, we’re inspired by technologies that have revolutionized how people spread and consume information. We often talk about inventions like the printing press and the television — by simply making communication more efficient, they led to a complete transformation of many important parts of society. They gave more people a voice. They encouraged progress. They changed the way society was organized. They brought us closer together.

The irony is that there were fierce fights about whether to open the network to students from other colleges. Facebook eventually opened the service not only to other colleges, but to the world at large, and it gradually changed the service’s default privacy settings so that more and more data was shared among its members. But at the same time, it has consistently sought to extend the sense of comfort that comes from a private network.

The company’s funding process has followed a similar trajectory. After early investments by elites like Sean Parker and Accel Partners’ Peter Thiel, the fledgling company opened itself up to an “Ivy League” of investors. This includes institutional investors and partners like Microsoft, but also a cleverly brokered deal from Goldman Sachs that allowed both the investment bank and its private clients to buy over $2 billion in Facebook stock at a $50 billion valuation.

Now, it’s going completely public. And this will force the company to seek new revenue. As it does so, it will have to make use of all that data openly shared by its members. But as usual, it must also ensure that it doesn’t push the boundaries too far.

Are You Just Yahoo In Disguise?

As it stands, many advertisers love Facebook. The attraction is that it’s less expensive and resource-intensive than traditional kinds of advertising. This makes it especially useful to small- and medium-sized businesses, who often don’t have the resources to produce a television commercial or magazine ad.

Even a powerhouse like Proctor & Gamble — which traditionally has a large marketing budget — is betting big on Facebook to help hold costs down. P&G is operating under the assumption that it can repeat its viral Old Spice hit, which generated 1.8 billion free impressions.

But what if P&G and other companies aren’t so lucky again? “We’re hearing from our clients that their return on investment from Facebook ads doesn’t look anything nearly like what it does for TV, print and radio ads, or from Google advertising,” said Forrester analyst Nate Elliott.

“I don’t think this will be a problem in 2012…. But if marketers find in 2012 that Facebook ads still aren’t delivering, I would worry about how much they spend in 2013.”

Elliott argues that if Facebook is to make good on its IPO, it has no choice but to make better use of the mountains of data it has collected about its users. Far from being an all-powerful juggernaut of personalized marketing, Facebook has coasted along on its popularity. “Facebook’s revenue model is exceedingly simplistic,” Elliott told Wired. “They sell lightly targeted static advertising badges. This is an ad model that hasn’t really changed since 1997.”

Thanks to the sheer number of visitors to Facebook, those simple ads have turned it into a multi-billion-dollar business, but ultimately, it’s not that different from any other web portal. “For a site that makes almost all its money from advertising, and which claims 96 of the top 100 U.S. advertisers as customers, Facebook harbors a dirty little secret: Marketing on Facebook doesn’t work very well,” Elliott writes on the Forrester blog.

“Facebook is the new Yahoo,” Elliott told Wired. “And they desperately don’t want to be Yahoo.”

Governments’ and privacy advocates’ biggest worry about Facebook is its stash of private data and how that data is used, but Elliott argues that Facebook hasn’t used that data as aggressively as it should. With the mind-boggling amount of information Facebook owns, it could create a system that powers intelligent, highly targeted ads not just on Facebook, but everywhere.

“Google is the template,” says Elliott. “Google has been a pioneer in finding creative and aggressive ways to use its data that are still legal and acceptable.”

Eye of the Regulator

The key words here are legal and acceptable. Facebook would have to walk a very fine line, properly anonymizing its data so that it doesn’t violate privacy laws anywhere (an increasingly difficult proposition) and making it clear to users how their data is being used.

A legislative or regulatory smackdown from Washington could stop Facebook in its tracks as easily as a user revolt. Even more worrisome is Brussels, where the European Union has been especially active in proposing internet privacy laws that make life exceedingly difficult for Facebook and other e-commerce sites.

Brussels could, for instance, author a simple mandate, one that Elliott says has been rumored to be proposed in 2013: All social networking and commerce sites have to allow for simple, universal, one-click export of all a user’s personal data.

On its face, it seems like the kind of thing users would want — and that the European Union or any other government in its capacity of regulating privacy and preventing monopolies would be within its authority to demand. But it would also leave Facebook at the mercy of any competitors, whether Google or anyone else, who could benefit immediately from the user data that Facebook’s platform has supported over the years.

After its IPO, Facebook will almost certainly invest some of its extra cash in advertising systems. But it will also pump additional dollars into public marketing and government lobbying. It must. A misstep in one direction, and it angers regulators and users. A misstep in the other, and it may lose advertisers.

The Next Facebook

Its a difficult position. But Facebook has a history of defying expectations. Federated Media’s John Battelle says that it’s still possible for Facebook’s sheer scale of users to surprise us — for the already-mature global company to continue to grow and change.

“Facebook is an extraordinary cultural phenomenon and a pretty extraordinary company,” Battelle told Wired. “They have an intensely high-speed culture, which is to their benefit. They’re fast, they’re iterative, they can adapt new features into their platform very quickly. And its leadership certainly doesn’t mind imposing its own sense of what should be normal on its users.”

All of this adds up to one formula: “Facebook is in the midst of becoming something other than what we thought it was.”

The company is trying to redefine itself as more than just a social network in the narrow sense in which we’ve understood it. “Facebook is now moving to another phase where it wants and needs to compete at any number of levels with Google, Microsoft, and Apple,” said Battelle. “Just as Google, after their IPO, became more than just search, and quickly made billion-dollar acquisitions, and then $10 billion acquisitions, and is now involved with just about everything, the same is true of a company that people think now is just social.”

“All of these companies are competing to become the operating systems of our lives,” Battelle added. “They want to be the place where we engage and store all of our data, and use it to do just about anything.”

These companies also share something else: they’re strongly founder-driven, which helps offset the demands of the stock market. “The companies that have been the most notably successful — Google, Amazon, Apple, Microsoft — all are guided by the supreme arrogance of their founders’ long-term vision,” Battelle said. “It’s almost a messianic quest to change the world.”

Zuckerberg, Battelle says, seems like that type of leader — and Facebook that type of company. After a $5 billion IPO, it will have to be.